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Charitable organizations can take many forms, such as partnerships, limited liability companies or C corporations. All of these organizations enjoy tax-exempt status under Internal Revenue Code Section 501(c). When the time comes to wind down the charity and liquidate its assets, you must follow certain procedures or face potential tax and legal liabilities.

Restrictions on Asset Distribution

To qualify as a nonprofit for Internal Revenue Service purposes, the organization's articles of incorporation must include a clause restricting the distribution of assets after liquidation. All assets and profits must be dedicated to supporting the organization's public purpose, even after it is dissolved. The charity may transfer its assets only to another nonprofit organization. If these provisions are violated, the IRS may deny the organization's exempt status and retroactively apply income taxes.

Liquidation Procedures

The organization must develop a written plan for liquidation and dissolution. The plan should list all of the organization's creditors and the amount of each outstanding debt. If assets must be sold to cover the debts, the liquidation plan should identify them and specify the method to be used. Approval from the secretary of state may be required in some states. If the charitable organization is operated by a government agency, that agency may also be required to approve the liquidation plan before any assets can be sold. This ensures that the plan complies with the charity's articles of incorporation and all applicable laws. The liquidation plan may not permit any transfer of assets or earnings to parties with a personal interest in the organization.

Dissolution Paperwork

Check your state law for the dissolution paperwork requirements for nonprofit C corporations. You will usually be required to send a notice of dissolution to the same state agency that handled your initial articles of incorporation. File a final tax return to close out the organization with the IRS. Cancel your employer identification number, close the corporation's bank accounts and cancel all fictitious business names. The board of directors may be held personally liable for the organization's obligations if it is not dissolved correctly.

Taxation of Gain

Liquidating assets that have appreciated in value create a gain for the organization. This gain will be nontaxable because the C corporation is exempt from income tax. Because the organization receiving the transferred assets must also be a nonprofit, the gain is never taxed. You may still need to record gain on the sale for accounting purposes, reports to donors or grant applications if the corporation or its founders plan to return to charitable work in the future.

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